A:

Holding an option through the expiration date without selling does not automatically guarantee you profits, but it might limit your loss. For example, if you buy a call option for stock A, which currently trades at $90, a decision has to be made as to whether to exercise the option at its expiration date, sell the option or let the option expire. Let's say the stock price goes up to $100 and the option cost is $2. If a decision is made to exercise the option, then the profit that would be made is $100-$90-$2 = $8.

It is important to remember that some types of options permit the holder to exercise the option at specific times. An American-style option has no restriction. It can exercised at any time between the purchase date and the expiration date. A European-style option, however, can only be exercised at expiration and Bermuda options have specific periods when exercise is permitted.

If the decision is made to sell the option, then the profit made may be slightly higher. If the option is sold before expiration date, then implied volatility and the number of days remaining before expiration may increase the price of the option. Let's assume that the price is higher by 10 cents. The profit made will be $10.10 - $2 = $8.10. The decision to sell the option assumes that it is in the money. If the option is out of the money, then exercising the option makes no sense at all because money will be lost if the stock is sold on the market.

One scenario that calls for letting the option expire occurs when you are holding a short position on an option that is out of the money. If you are short a put option that is worth $2, closing the position will cost you $2 plus commission. However, letting the option expire will only cost you $2. In this case, no profit is made, but losses were limited.

To learn more, check out our Options Basics Tutorial.

This question was answered by Chizoba Morah.

http://web.streetauthority.com/terms/options/3.asp

RELATED FAQS
  1. What happens when an option expires in money? Do I have to sell the option to make ...

  2. Can an option be exercised on the expiration date?

    The use of options has increased dramatically over the years as a way to profit from or hedge against the volatile movements ... Read Answer >>
  3. How do I change my strike price once the trade has been placed already?

    Learn how the strike prices for call and put options work, and understand how different types of options can be exercised ... Read Answer >>
  4. How can derivatives be used to earn income?

    Learn how option selling strategies can be used to collect premium amounts as income, and understand how selling covered ... Read Answer >>
  5. After exercising a put option, can I still hold my option contract in order to sell ...

    Once a put option contract has been exercised, that contract does not exist anymore. A put option grants you the right to ... Read Answer >>
  6. How are call options priced?

    Learn how aspects of an underlying security such as stock price and potential for fluctuations in that price, affect the ... Read Answer >>
Related Articles
  1. Investing

    Getting Acquainted With Options Trading

    Learn more about stock options, including some basic terminology and the source of profits.
  2. Investing

    4 Reasons To Hold Onto An Option

    There are times when an investor shouldn't exercise an option. Find out when to hold and when to fold.
  3. Trading

    American Vs. European Options

    These two options have many similar characteristics, but it's the differences that are important.
  4. Investing

    Types of Options

    There are many different types of options. In addition to general put options and call option, we will discuss 13 different types of options. Some of these option types are better suited to day ...
  5. Trading

    Three Ways to Profit Using Put Options

    A brief overview of how to profit from using put options in your portfolio.
  6. Investing

    Exploring The World Of Exotic Options

    Exotic options provide investors with new alternatives to manage their portfolio risks and speculate on various market opportunities. The pricing for such instruments is considerably complex, ...
  7. Trading

    What Drives An Option's Price?

    The primary drivers of an option’s price are the underlying stock’s current price, the option’s intrinsic value, its time to expiration and volatility.
  8. Investing

    American Vs. European Options—Key Differences

    There are four key differences between American- and European-style options.
  9. Trading

    The Basics of Options Profitability

    The adage "know thyself"--and thy risk tolerance, thy underlying, and thy markets--applies to options trading if you want it to do it profitably.
  10. Trading

    Introduction - Day Trading and Options

    Options have not been a tradition part of day-trading strategy, but this is quickly changing.
RELATED TERMS
  1. Call On A Call

    A type of compound option in which the investor has the right ...
  2. Expiration Date (Derivatives)

    The last day that an options or futures contract is valid. When ...
  3. American Option

    An option that can be exercised anytime during its life. American ...
  4. Early Exercise

    The exercise of an option prior to its expiration date. Early ...
  5. Bermuda Option

    A type of exotic option that can be exercised only on predetermined ...
  6. European Option

    An option that can only be exercised at the end of its life, ...
Hot Definitions
  1. Sell-Off

    The rapid selling of securities, such as stocks, bonds and commodities. The increase in supply leads to a decline in the ...
  2. Brazil, Russia, India And China - BRIC

    An acronym for the economies of Brazil, Russia, India and China combined. It has been speculated that by 2050 these four ...
  3. Brexit

    The Brexit, an abbreviation of "British exit" that mirrors the term Grexit, refers to the possibility of Britain's withdrawal ...
  4. Underweight

    1. A situation where a portfolio does not hold a sufficient amount of a particular security when compared to the security's ...
  5. Russell 3000 Index

    A market capitalization weighted equity index maintained by the Russell Investment Group that seeks to be a benchmark of ...
  6. Enterprise Value (EV)

    A measure of a company's value, often used as an alternative to straightforward market capitalization. Enterprise value is ...
Trading Center